1confirmation partner: three counter-intuitive lessons in crypto VC investing
Written by: Richard Chen, Partner at 1confirmation
Compile: TechFlow
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1. Portfolio construction is more important than selecting the right target
This lesson is the most counter-intuitive, but it's actually quite simple from a data point of view:If you invest only 0.5% of your money in something that returns 100 times, you will not get back your money.Since VC returns follow a power law distribution, 100x return winners are uncommon, so every time you come across one, you have to make the investment more valuable.Concentrated investment > prayerful diversification.
A VC collects a bunch of pretty logos on the portfolio page of their fund website, which doesn't mean their returns are really good looking, but that's what portfolio construction is all about, and that's why I'm so concerned about $400 million+ Funds are still baffled by writing seed round checks.
Some see small initial investments as a way to get a "shot" and prepare to massively double down on winners in subsequent rounds. But what actually happens is,In the later stage, larger foundations entered the market with a stronger posture and obtained almost all the shares(i.e., the later you invest, the more zero-sum the chance) Furthermore,If you are not the main investor in the seed round, you will probably not get your share proportionally, and the ownership will be diluted a lot(I've seen a 90% example).
If you take this lesson to its logical limit (i.e. picking the right company doesn't matter at all), then the optimal portfolio structure is to have 100% of the USD invested in ETH -This is called beta investing.
But to be honest, one of the dark secrets in cryptocurrency venture capital investment is that at the beginning of the last cycle, most funds did not perform better than DCA (Dollar Cost Averaging) in investing in ETH. called regular fixed investment method).
Assuming that the reasonable cost basis of ETH is $200, if you invest in ETH at the cost of USD between 2018 and 2020, your fund TVPI (fund return multiple) will be 15 times today.
As a counter-example, many will point to a famous study done by AngelList showing that, on average,Foundations that invest more have better returns. But I think cryptocurrencies are different. Because the equivalent benchmark returns in the public market (such as DCA into ETH) are already high, you need to focus on asymmetric returns to have a chance of outperforming the majority.
Otherwise, over time, the average return on a cryptocurrency venture would be lower than just buying ETH.In the long run, it is very difficult to surpass the performance of ETH.
Therefore, with every new investment you should consider the"Will this exceed my ETH bags, can I get back my money?"first level title
2. Before product-market fit, there is little correlation between the "hotness" of a round of financing and the final outcome
When you look at who the biggest winners have been in the last cycle in history, almost none of them were hot deals at the seed round.
DeFi：Uniswap may have been a hot spot in the market once, but Aave, back when it was called ETHLend, was available to any retail investor for pennies on the open market. In fact, all Ethereum DeFi wasn’t an attractive enough investment until DeFi Summer happened (and the new BitMEX competitor was super hot).
NFTs：While DeFi is all the rage with Degen Yield for Yield Mining, SuperRare Cryptoart is still being completely ignored. The base price of XCOPY and Pak pieces is still in single ETH.
L1s：Ironically, Solana was one of the only "VC chains" and wasn't a hot trade at the time (unlike Dfinity, Oasis, Algorand, ThunderToken, NEAR, etc.), and now it's the top performing Alt L1 investment.
That's why valuations are very tightly controlled at the seed stage. I sawMore and more venture capital companies will enter the seed round of the product with a valuation of 60 million to 100 million US dollars.The only reasonable exception I can think of is L1s due to their high TAM (Total Addressable Market) cap. But on top of that, you can even buy publicly traded tokens with potential but cheaper FDV (fully diluted valuation) for less than those product seed rounds.
After product-market fit, however, the exact opposite is true: the best investments are those that are the most clear winners. This is because humans naturally have a hard time internalizing the feeling of exponential growth—we tend to underestimate how much the winners can really win and become monopolies.
OpenSea's pre-Series A valuation of $100 million seemed high at the time, but given how quickly their deal volume was growing, it quickly became a bargain.
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3. It's hard to pick a winner in the crowded space of popular narratives
One trend I've seen over the past year is thatWeb2 founders tend to build those hottest Web3 narratives, is also the most crowded space.
A lot of VCs point to this as a sign of great talent entering the crypto space, but I think it's more about talent from good schools entering the space than necessarily a good founder-market fit.
Cryptocurrencies may not be like other industries, and historically, nearly all of the most successful crypto projects were founded by people with no Ivy League/Silicon Valley pedigree.
I have some concerns about investing with obvious ideas:
These ideas attract mercenary-like founders who are mercenary.These founders are good at replicating what has been successful (e.g. Ethereum DeFi to other L1 chains, existing web2 SaaS products for web3 DAO) and aggressively market their products. But it is inevitable that as the cryptocurrency rotates to the next hot narrative, the size of the founders will shrink. For example, we are seeing this situation now, Ethereum DeFi tokens have fallen by 70-80% from their all-time highs, while DeFi on other chains has become the new hot narrative. Among the Ethereum DeFi projects launched in the 2020 DeFi Summer, those mercenary-like founders who are profit-seeking have turned to angel investment, while those who are missionary-like founders have a product vision and continue to build and innovate.
A good way to gauge mercenary vs. missionary founders is to walk through the thought maze with them—that is, to see if the founders can talk about all the ways they were doing before and the better ways they are doing it now.If the VC knows a lot more about a field than the founders, that's a red flag.
The competition for these ideas is strong.When there are a dozen projects trying to build the same thing (like the Solana lending protocol), it's even harder to pick a winner. Each category remains largely a winner-take-all or duopoly-take-all business. If you take a concentrated approach (according to point 1 above), then you can't pray for diversification over your competitors due to conflicts of interest.
These ideas have high pre-production valuations.The lowest valuations I've seen for the X-chain right now are $40-60 million pre-prod, sometimes $100-200 million. This risk/reward might be fine for a trader looking for a quick pre-sale to token launch, but not for a VC looking for an asymmetric return on investment.
I cannot give a complete conclusion, so I will end this article with a hot topic.Original link
